DENVER—The Colorado State Assembly passed a new law this month that regulates qualified intermediaries and other 1031 exchange facilitators. “To protect taxpayers who engage exchange facilitators, exchange facilitators should meet certain requirements and follow certain procedures,” the bill states. With it, Colorado becomes the third state to enact some kind of regulation of exchange facilitators, after Nevada and California.
The new Colorado law requires exchange facilitators to maintain a fidelity bond of at least $1 million and errors and omissions insurance of at least $250,000, and to either hold cash or irrevocable letters of credit in at least those amounts in a deposit or money market account or “deposit all exchange funds in a qualified escrow or qualified trust… with a financial institution and provide that any withdrawals from such qualified escrow or qualified trust require the taxpayer’s and the exchange facilitator’s written authorization.”
In any case where the exchange funds are in excess of $250,000, the law requires that the funds be “deposited in such a manner as to require both the taxpayer’s and the exchange facilitator’s commercially reasonable means of authorization for withdrawal.”
It also requires that the exchange facilitator “shall invest or deposit exchange funds for the benefit of the taxpayer in investments that meet a standard of care that an ordinarily prudent investor would use when dealing with the property of another, and shall satisfy investment goals of liquidity and preservation of principal.”
Other key aspects of the law include the requirement of exchange facilitators to act “as a custodian for all exchange funds,” which it says “means a person who has the same responsibilities as a fiduciary under Colorado law to protect and preserve assets.” The law prohibits exchange facilitators from commingling exchange clients’ funds with its own operating funds and says that when clients’ funds are aggregated each exchanger’s funds must be readily identifiable.
“We applaud Representative Judd and Senator Harvey for supporting legislation that protects the integrity of the services provided by QIs doing business in Colorado,” says Accruit LLC president and CEO Brent Abrahm, in an announcement, noting the two state legislators who sponsored the bill.
Meanwhile, there have been developments in recent weeks in two large QI failure cases that first made headlines in 2007.
In Las Vegas, a Clark County grand jury indicted Nikki Pomeroy, who was an officer and director of the former Southwest Exchange Co., with 11 counts of embezzlement and 11 counts of unlawful intermediary in a tax-free exchange, according to an announcement from Nevada’s attorney general. The charges stem from what Nevada Secretary of State Ross Miller calls “quite possibly the largest case of embezzlement in the history of the state.” More than $97 million of exchangers’ money was lost in the case, the state says.
The charges against Pomeroy, who was scheduled to be arraigned in Las Vegas District Court today 9, followed “an extensive 24-month investigation [that] was done by the Nevada Secretary of State’s office into how the exchanger clients’ funds were used by Southwest,” according to the announcement. “The investigation revealed numerous unauthorized transfers of client funds to third-party accounts and companies, which were done without the authority or knowledge of Southwest’s clients.”
“The indictment alleges Nikki Pomeroy, in her capacity as secretary and director of Southwest Exchange, transferred funds out of the Southwest Exchange accounts without the written permission of Southwest’s exchange clients,” the announcement continues. “This permission is required by Nevada law.”
And in Richmond, VA last month a federal jury convicted Edward Okun, once the owner of qualified intermediary company 1031 Tax Group LLP and TIC sponsor Investment Properties of America, of 23 counts of conspiracy to commit mail and wire fraud, conspiracy to commit money laundering, bulk cash smuggling and perjury. According to the US Department of Justice, evidence during Okun’s trial showed that he and others “used 1031TG and its subsidiaries, all owned by Okun, in a scheme to defraud clients” to the tune of approximately $126 million.
“The evidence presented at the trial established that 1031TG obtained funds by promising clients that their money would be used solely to effect 1031 exchanges as outlined in the exchange agreements,” according to the DOJ announcement. “After making such promises, evidence showed that Okun and others misappropriated approximately $126 million in client funds, to support his lavish lifestyle, pay operating expenses for his various companies, invest in commercial real estate and purchase additional qualified intermediary companies to obtain access to additional client funds.”
Okun remains in custody awaiting sentencing, which is scheduled for August 4. Maximum prison terms range from 5 to 20 years for each count of which he was found guilty. Three others charged in the 1031 Tax Group case have entered guilty pleas and are scheduled for sentencing on August 13.